December 5, 2011

Key Investment Themes And 2012 Outlook

As 2011 draws to a close, we present our key investment themes and 2012 market outlook.

by iFAST Research Team

2012 INVESTMENT THEMES/OUTLOOK:

1. Investor Sentiment set to improve in 2012. 2011 has been characterised by weak investor sentiment and an aversion for risk. We expect to see improved investor sentiment, as the market climbs the proverbial wall of worry. A recent Merrill Lynch poll of fund managers in November 2011 indicated that a net 5% of the respondents were underweight equities, while the extremely low yields in safe assets like US Treasuries are a function of heightened investor risk aversion. Despite the various issues highlighted repeatedly by the media in 2011, the global economy has continued to plough along, and corporate earnings remain on track for growth. Financial markets are lacking in confidence, and we expect to see a reversal of investor sentiment as growth (in both corporate earnings and economic growth) persists into 2012, leaving investors with fewer concerns. 2. Chinas Policy Reversal as a Key Market Catalyst. The importance of China in the global economy cannot be understated. In addition to being one of the largest exporters in the world, Chinas 1.3 billion population wields tremendous consumption ability, and the country is now estimated to account for about 36% of the global economys growth in 2011 (source: Conference Board). The Peoples Bank of China (PBOC) has hiked rates in response to inflationary concerns, but with fears rife over a potential hard landing in China, we now think a reversal in monetary policy is imminent, which could help to quell growth concerns. The PBOC recently cut the Reserve Requirement Ratio (RRR) by 50bp, the first cut in three years, and further signs of a reversal in monetary policy could be a key catalyst in sparking a stock market rally. 3. No Eurozone Breakup seen. We remain focused on the difference between solvency and liquidity economies like Spain and Italy are solvent, but are finding it difficult to access liquidity and identify that while long term austerity will be required to reduce heavy debt burdens for troubled Eurozone countries, it is the near-term liquidity constraints which have the potential to shock financial markets. While we clearly do not have a crystal ball to predict how the crisis will play out, we believe that there are sufficient options (IMF funding, increasing the scope of the ECB as a buyer of last resort etc.) available which can buy troubled Eurozone economies sufficient time for cost-cutting measures to be effective, but these measures require European leaders to act decisively, and in concert. With the negative repercussions of a Eurozone breakup far outweighing any benefits derived, we do not view a breakup as a viable outcome. 4. Global Growth to Moderate in 2012, but investors to seek out higher-growth opportunities. Our expectations are for a mild contraction in the Eurozone in early 2012, which will undoubtedly weigh on overall global growth. While the US economy is still expected to expand in 2012, growth rates are still forecasted to be relatively tepid. In an environment where growth is scarce, we expect investors to take the cue from multinational corporations which are increasing investments in faster-growing Emerging Market (EM) countries.

5. Inflation to be relatively benign in 2012. In 2011, inflation in Asian economies has been driven by sizable gains in oil, food and property prices. From the relatively elevated levels of 2011, commodity price gains are not likely rise by a similar magnitude (especially considering the slower economic growth anticipated), which should allow for more benign inflation in the region. More targeted policy responses in the housing market in countries like China, Singapore and Hong Kong may help to moderate property price gains, easing headline inflation further. 6. Monetary tightening to turn accommodative. As growth fears take precedence over inflationary concerns, we expect most Central Banks (and not just the PBOC) to embark on a more accommodative monetary policy stance, as opposed to further tightening measures seen in 2010 and early 2011. Central bankers in Australia, Brazil and Indonesia have already cut rates in 2011, while others like South Korea and Malaysia have recently left rates on hold. Accommodative monetary policy will help reduce downside risks to growth, but may also weigh on currency appreciation expectations for EM currencies. While purchasing power parity suggests a long-term trend of appreciation for EM currencies against the USD, there are near-term risks should monetary policy in EM countries ease more than anticipated. 7. Politics - both a risk and opportunity in 2012. 2012 will see a flurry of elections; notably, the presidential election will be held in the US. In an attempt to slash government spending, sectors like healthcare and defence are likely candidates to experience some negative impact from new government budgets, while potential tax breaks may see easier (and cheaper) repatriation of overseas capital for US companies, which could be used for dividend payouts or share-buybacks. Pro-economic policies are likely to be formulated across various countries, while electorate-friendly measures may provide a boost to household spending. 8. Bubble formation? But where are the excesses? We believe that a long-term build-up of excesses often signals problems in a particular sector, country or asset class. While we do not observe that in the corporate sector at present, government debt levels are relatively high in developed economies, the very same debt securities which investors are plying into at record-low yield levels. In addition to developed sovereign debt, gold appears to share the same characteristics, having risen for 11 consecutive years even as demand has been relatively muted in recent times.

IMPLICATIONS FOR INVESTORS

1. 2012 to be a strong year for equities. While equity valuations are at multi-year lows, investor confidence is clearly lacking. As companies sustain their profitability and the global economy steers clear of recession, stock markets have the potential to rally strongly from their current depressed valuations on any semblance of a catalyst. In contrast, historicallylow yields remain a feature of global fixed income market. We maintain our overweight recommendation on equities vis--vis bonds. Our recommended global equity funds are the Alliance Global Equities Fund, RHB Global Fortune Fund and AmOasis Global Islamic Equity. 2. Emerging Market equities to find renewed favour. EM equities are likely to find renewed favour with global investors after a disappointing 2011, and with growth opportunities scarce, we may see faster-growth EM equities commanding a sizable valuation premium against developed market equities going forward. Our recommended emerging market equity funds are the AmGlobal Emerging Markets Opportunities. Recommended funds in the Asia ex-Japan region (which forms over half of the Emerging Markets benchmark) include Prudential Asia Pacific Equity Fund and Prudential Asia Pacific Shariah Equity Fund. 3. China equities poised to deliver strong returns. After strong gains in 2009, China equities delivered poor returns in both 2010 and 2011, despite the China economy maintaining a rather blistering pace of growth. On our estimates, China equities are valued at just 8.7X 2011 earnings (representing multi-year low valuations), and valuations decline to a paltry 6.8X 2013 estimated earnings (as of 25 November 2011). With extremely

supportive valuations coupled with a shift towards more accommodative monetary policy, we think China equities are poised to deliver extremely strong returns from their current levels. The OSK-UOB Big Cap China Enterprise Fund focuses on China companies while the Manulife Investment - China Value Fund has a strong track record investing in the Greater China region, which comprises China, Hong Kong and Taiwan. 4. European equities volatile, but remain cheap and necessary for portfolio diversification. Europe has been a constant source of worry for most investors, and given that the situation remains fluid, we anticipate significant volatility in European stocks. Our valuation approach for European equities takes into account a forecasted mild recession in 2012 and its corresponding negative impact on profits. Nevertheless, even on our conservative estimates, European equities remain attractive despite our recent downgrade, and we deem exposure to the regions equity market necessary for portfolio diversification. The TA European Equity Fund offers exposure to European-based companies which also derive a substantial portion of revenue from outside Europe. 5. Indonesian equities least favoured, following three consecutive strong years. With its relatively shielded economy, Indonesia appears to have found favour with investors in recent years. Nevertheless, valuations for Indonesian equities are fair at best following three strong years of performance, and the market is less attractive compared against other markets as well as taking into consideration the high domestic government bond yields. 6. Riskier fixed income segments more attractive. Even as fixed income has generally fared well in 2011, riskier segments like high yield bonds have been negatively impacted by heightened risk aversion. The Asian high yield space now offers some of the highest yields within fixed income, while spreads in the US high yield space have also risen. Yields on emerging market debt remain high relative to developed sovereign debt, and investors may benefit from a potential convergence in yields between developed and developing market debt. The AmEmerging Markets Bond is our recommended fund in this area. 7. Underweight developed sovereign debt. While our expectations of moderating growth and inflation are generally supportive conditions for developed sovereign debt, G7 sovereign yields remain at some of the lowest levels on record, a manifestation of investor risk aversion. Yields on developed sovereign bonds now offer too little to compensate investors for interest rate and potential inflationary risk, and also represent extremely poor long-term returns. 8. Avoid gold. Gold has continued to surprise us with strong gains in 2011, which should cap eleven consecutive years of gains. Gold bulls point to large sovereign debts and deficits to make their case for the shiny yellow metal, and also talk about its inflation-hedging properties. Even so, global demand for gold in 3Q 11 rose a paltry 5.5% year-on-year in volume terms (according to the World Gold Council) while jewellery demand actually fell 10% year-on-year. On the other hand, prices rose by 24.1% (in USD terms) over the same period, highlighting a clear disregard for supply and demand factors. Investors should be cautious on gold (which does not get destroyed over time, but rather, is recycled) and would urge investors not to time the peak, hoping to exit before the house of cards eventually collapses.
The Research Team is part of iFAST Capital Sdn Bhd
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